Good afternoon, ladies and gentlemen. Thank you for joining Dropbox's Third Quarter 2022 Earnings Conference Call. All participants will be in listen-only mode. After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] As a reminder, this conference call is being recorded and will be available for replay from the Investor Relations section of Dropbox's website following this call. I will now turn it over to Karan Kapoor, Head of Investor Relations for Dropbox. Mr. Kapoor, please go ahead.

Thank you. Good afternoon, and welcome to Dropbox's Third Quarter 2022 Earnings Call. Before we get started, I'd like to remind you that our remarks today will include forward-looking statements such as our financial guidance and expectations, including our long-term objectives and forecasts for our fourth quarter and fiscal year 2022 and our expectations regarding our revenue growth, profitability, operating margin, free cash flow as well as our expectations regarding our business, assets, products, strategies, technology, employees, users, demand and markets. These statements are subject to risks and uncertainties that could cause actual results to differ materially. They are also based on assumptions as of today, and we undertake no obligation to update them as a result of new information or future events. Factors and risks that could cause our actual results to differ materially from these forward-looking statements are set forth in today's earnings release and in our quarterly report on Form 10-Q filed with the SEC. We'll also discuss non-GAAP financial measures, which are not prepared in accordance with generally accepted accounting principles. A reconciliation of GAAP and non-GAAP results is provided in our earnings release and on our website at investors.dropbox.com. I would now like to turn the call over to Dropbox's Co-Founder and Chief Executive Officer, Drew Houston. Drew?

Thanks, Karan, and good afternoon, everyone. Welcome to our Q3 2022 earnings call. Joining me today is Tim Regan, our Chief Financial Officer. I'll first share some business and product highlights from the quarter, and then Tim will discuss our Q3 financial results and provide guidance for the remainder of the year. We delivered another strong quarter amidst an increasingly challenging macroeconomic backdrop. We saw strength from our teams plans driven by pricing and packaging changes, which we rolled out in June. And the strength was partially offset by some continued moderation in our document workflow businesses which I touched on last quarter, along with some recent softness with our Plus individual SKU, particularly in mobile. Like many of our peers, we're keeping a close eye on the evolving economic climate and the potential impacts to our own business, which Tim will speak to in a moment. During these uncertain times, it's especially critical, we pay close attention to how we continue to best serve our customers by remaining focused on simplifying users workflows and keeping security top of mind or driving higher value to business users when they need to be more strategic for their spend. And we're doing this, while thing disciplined ourselves as demonstrated once again by our stronger-than-expected profitability, which Tim will also discuss. And as we approach 2023, we remain committed to the strategy we outlined earlier this year. First, we continue to evolve our core FSS offering by improving the user experience to set a stronger foundation for future growth. Second, we're innovating in workflows beyond storage, particularly in documents and videos to better serve the growing needs for freelancers and small business teams. And finally, we're focused on maintaining operational excellence as we continue to balance growth and profitability. I'll start with how…

Thank you, Drew. Before turning to our quarterly results, I'd like to start with a reminder of our financial strategy. We are continuing to pursue sustained growth and profitability in a disciplined and thoughtful manner while remaining committed to our long-term objectives. We also remain focused on allocating capital to growth initiatives that we believe will drive future revenue, both organically and through acquisitions while also returning a significant portion of our free cash flow to shareholders in the form of share repurchases. As Drew highlighted, we are keeping a close eye on the macro environment, and in particular, foreign exchange rates, where we continue to see intensifying headwinds from the strengthening dollar. I will discuss this in more detail shortly. Let's start with our third quarter performance, and I'll provide updated guidance for the remainder of the year. Beginning with our third quarter results. Total revenue for the quarter increased 7.4% year-over-year to $591 million, beating our guidance range of $584 million to $587 million. Foreign exchange rates provided an approximate $13 million headwind to growth, in line with our previous expectations. On a constant currency basis, revenue grew 9.7% year-over-year. Total ARR for the quarter grew 9.6% year-over-year for a total of $2.431 billion. On a constant currency basis, ARR grew by $98 million sequentially and 10.2% year-over-year. This step-up is sequential ARR and acceleration in our year-over-year growth on a constant currency basis was largely driven by pricing and packaging changes with our Teams plans that we announced in June, which Drew touched on earlier. We exited the quarter with 17.55 million paying users and added approximately 180,000 net new paying users in the third quarter. Average revenue per paying user was $134.31 in Q3, up nearly $1 from Q2, primarily driven by increased pricing on our…

[Operator Instructions] Our first question comes from Rishi Jaluria with RBC Capital Markets. You may proceed.

Nice to see continued strength in spite of the macro headwind. I've got one question for Drew, one for Tim. Drew, I wanted to start -- in your prepared remarks, you talked about how you're seeing continued strength in DocSend, which I'm pleasantly surprised to hear in spite of kind of a softer VC funding environment. Can you talk a little bit about what's driving that in DocSend? And you talked about kind of wanting to explore or drive newer use cases for DocSend. What would some of those look like?

Sure. Thanks for the question. So DocSend continues to be one of our fastest-growing businesses. I mean, we have -- just to be clear, we have seen headwinds given DocSend's exposure to the fundraising market, which -- and so fundraising activity has come down. So just to be clear, we have seen some headwinds there. That said, there are a lot of different verticals that revolve around sending content and needing to have analytics around it and the kind of things that DocSend provides. So we're seeing a lot of opportunity in new verticals like professional services and sales and customer success, account management. So in short, we're branching out into other customer segments and adding new kinds of value. And so for example, on things we added last week in our launches with advanced video analytics. So we see continued opportunity for DocSend, but there will be a -- we believe there will likely be a mix shift to other customer segments as the funding activity moderates.

Got it. That's really helpful. And then, Tim, if we -- wanted to maybe get a sense, look, if we look at the numbers, right, we saw overall revenue growth accelerated about slightly under 1% constant currency, ARR accelerate by about 2 points constant currency. Now you did mention some of that was obviously the uplift from the pricing and packaging changes. To the extent you can, can you help us understand what was the actual impact in the quarter from those? And without thinking about guidance for next year, just when does it kind of flow through from this and so we're not over extrapolating from this quarter?

Sure. So we don't break out the pricing contribution separately. I'll give you a bunch of the pieces here. So we did raise prices by 20% on our Standard and Advanced Team plans. And so for new customers, they began purchasing the higher-price plans starting in June. Existing customers began renewing at the higher price point starting in July. And the subset of our user base that is ultimately subject to the price increase comprises about 1/3 of our total ARR and the majority of those customers will see the pricing increase this year with the remainder landing in '23 as well as 2024 for some of our managed accounts. And then just given how we recognize revenue, the revenue will these billing cycles flowing to 2022 and beyond. And of course, within this quarter, a large portion of that step-up did come from our monthly customers as they became subject to the change.

Our next question comes from Brent Thill with Jefferies. You may proceed.

This is Luv Sodha on for Brent Thill. Congrats on a solid trend here. Just wanted to ask maybe first one for Drew. One of the comments you made in the prepared remarks was around churn rates for Teams plans being down despite the price increase. I guess could you unpack that a little bit just because given the environment we are in today, some of the other companies are facing higher churn within the SMB side. So just unpack the customer base and what drove that strength there?

Sure. So I'd say a couple of parts. So one is churn or customer retention has been improving overall in the core business, and that's a trend we've been seeing continue. I'd say on the price increase or the new plans, I'd say churn is ahead of our expectations. And so we -- basically, it's gone -- or the packaging changes have gone better than we anticipated. And part of what's driving this is -- or part of why we believe it's going better than expected is we see the packaging and pricing changes as part of a flywheel where first, we create new customer value. And so in this case, it wasn't just a price increase. We also introduced a lot of security features for Teams that had been in response to customer demand. So for example, ransomware attacks are way up like 300% up in the last year, something between 50% and 75% of the victims are SMBs, don't have dedicated IT security resources. And so we've been building in that direction because we see that it will be a growth area. And you need security in any kind of macroeconomic environment. So we see that it's a positive -- overall, we see -- when we look at how the macro environment is affecting us, we've been pleased by the stability so far. That said, we don't want to -- we know it's an evolving situation, so we're going to be cautious and monitor all these signals really closely for changes.

Got it. And then one for Tim. I know you're raising the guide for this year, obviously. But how should we think of the level of conservatism embedded into this guide? Is it similar to what you have embedded previously? Are you embedding more conservatism given the environment we're in? Just any color there, Tim.

Sure. I'll just say that there are no material changes from our historical guidance approach. We continue to guide to what we have a high degree of visibility into and we factor in growth initiatives when we have sufficient signal on their performance. And as we see additional data over the course of the year, as we are seeing with these changing macroeconomic conditions, we do revise and incorporate those trends into our guidance as needed.

Our next question comes from Mark Murphy with JPMorgan. You may proceed.

This is [indiscernible] on for Mark Murphy. And I'll reiterate the congrats on the quarter. On the softness you mentioned in some of the business segments that saw a bit of elevated demand during the pandemic, would you say that some of the pressures here were consistent with the prior quarter? Or did they incrementally worsen? And any sense of when you expect to see a bit of a plateau in some of the softness?

Sure. So we are seeing some incremental macro headwinds in our Dropbox Sign business. As we do lap COVID tailwind and then we are also seeing DocSend slow down a bit, just given that a fair amount of that business of macro-related softness around some of our Plus users, particularly on mobile. So, all of those components have been factored into our guidance. I'm not going to give forward-looking guidance beyond Q4 at this point. And certainly, as I mentioned to Luv, we factored in these baseline trends -- these updated trends into our guidance for the rest of the year.

Got it. That's very helpful. And then as a quick follow-up on the topic of the recent 20% price increase. Is there any change in the level of elasticity among customers relative to some of the prior price increases that you've done, particularly given the inflationary environment?

I don't think we break out specific stats on that. I can -- what I can say is that we've certainly taken to account, as you'd imagine, when we project the impact of price increases, how those have gone in prior cycles. And I can say that Teams price increase has gone better than expected.

Our next question comes from Steve Enders with Citi. You may proceed.

I just want to ask you, I guess, on the pricing and packaging dynamics. I mean it seems like there's been really good success with the Teams increase in the past quarter. I guess how are you thinking about kind of more broadly raising prices on some other plans or thinking about shifting some of the packaging to potentially drive an increase of pricing in that way?

Well, I think it starts with our philosophy, which has been pretty consistent. And as I mentioned before, we start by creating value, so adding new features in response to customer demand. So the Teams' price increase, for example, was paired with a lot of the security features around ransomware protection and backup and passwords, that customers have been asking for. And then we add new products, right? So Capture, Dropbox Capture, a new product is available to all paid subscribers. So it's another example of creating value. And then we change prices or change packaging. As our portfolio, we see that a lot of our customers obviously not only need to store and share and sync their files, but have a lot of workflows around them. And as we have a broader portfolio of products that address these workflows like Dropbox Sign, DocSend, a big opportunity is bundling, right? And when you look at other SaaS companies, there's been a lot of success there. And bundling economics are obviously great for customers, and there are also favorable economics for the Company. So I'd say we're early innings in terms of thinking through bundling and we'll be doing more here, especially as customers are also thinking about how they consolidate, how do they -- or how to consolidate their tools, manage spend more effectively. We think having more suites and all-in-one type solutions will resonate in a challenged environment.

Okay. Got you. That's helpful. I guess on the Plus plan, I know that there's been kind of more focus from you historically just in terms of like trying to drive conversion rates in the app and trying to help kind of improve some of those retention trends. I guess, how do you kind of think about the levers that of improve some of the retention rates on the Plus side or drive further conversion?

Yes, I can start. I mean, first, we've just seen good returns to just improving the core experiences and streamlining some of the basics. So we found that there by removing friction from our onboarding experiences, by making sharing more seamless, by improving like photo backup speeds, things like that, just the nuts and bolts, we see engagement increase, we see retention improve. So we continue to invest in those kinds of levers. And then I mean there are going to be puts and takes with any individual SKU. We also think about, let me zoom out a little bit from any one of the SKUs and think about how do we direct our customers and match them with the most compelling offering for them. And so I think we've also been driving a mix shift from Plus towards higher value plans like Professional or our Teams plans that have more like network effect driven retention and things like that. So I'd say within any individual SKU there are a number of levers as far as how we monetize the specific offering, churn versus pricing, other things like that. But then we also look at it from a portfolio level and making sure we're making -- and ensure we're making globally optimized decisions.

Our next question comes from Joey Marincek with JMP Securities. You may proceed.

Congrats on the nice results here. Drew, can you talk more about security? What is it that customers -- what our customer needs as it relates to security? And what are some ways Dropbox can help? And then maybe additionally, can you touch on the GitHub phishing incident? What happened and what steps have you taken?

Sure. Great question. So on the security front, from a customer demand standpoint, the landscape continues to evolve, right? And so as I shared before, ransomware attacks have been up almost 300% in the last year, something like half to 3/4 of the victims are small businesses, so we see new demand. And those small businesses, half of them don't have dedicated IT security resources. So we see a big opportunity for Dropbox to help in a number ransomware protection to more fully featured backup options in a world where people are now working from everywhere, being able to back up all your endpoints is something that where -- revenue needs, managing passwords for a team. And so there's a lot of different areas where we've been launching new security functionality that's been resonating with customers and has been in response to new demands, and that has been a big part. We see that the adoption of those new features and the success of the price increase and packaging changes, the security features we've launched have been instrumental to that. Second, just sort of background, you mentioned the GitHub phishing incident in October. We were the targeted fishing campaign and one of our employees. GitHub accounts was compromised. We resolved the issue quickly. We believe the overall impact is minimal, specifically the kinds of things we look at are -- our apps, core service code, production environments were not accessible. No evidence that customer content or passwords or payment information was compromised. No indication that there will be material business or customer impact. Definitely we like to be transparent about how we handle these kinds of incidents and we've posted -- there's a lot more detail on our blog, but again, we think we've responded quickly and don't believe there will be a material impact.

That's very helpful. And then can you also give us an update on Command E. How is it performing relative to expectations? And what's your ultimate vision there?

Very excited about Command E, and we see a big opportunity in evolving the Dropbox experience. And when I started the Company, it was really about how do I sync my files across different devices, different operating systems. And today, we have -- we all have new challenges where a lot of work has moved into the browser and a lot of cloud tools, but then there's new problems around fragmentation. And the challenges around the basics like not being able to find information, not being able to organize it. So Command E is a great example of addressing some of those challenges. So instead of having 10 different search boxes for 10 different apps, Command E provides universal search. We bought that company about a year ago. We've been investing more there. And we think that there are fundamental needs in the cloud world around organizing your content and evolving Dropbox from syncing files to organizing all your cloud content. That's a big opportunity in any macroeconomic environment. So we'll have more to share on the road map there and new product experiences in the coming quarters.

Thank you. One moment for questions. Our next question comes from Matt Bullock with Bank of America. You may proceed.

I'm on for Mike Funk. Just wanted to triple tap here on the pricing increases. So, we did see a deceleration in net adds of around 100, 000 from this -- the average of the past couple of quarters. I'm trying to frame that decel in terms of pricing impact versus the plus weakness in mobile. Was most of that decel driven by the pricing increases? And if so, can we assume that now that the monthly users have digested that, that we could see a resell in net adds going forward?

Sure. This is Tim. I'll take that. So we added about 180,000 net new paying users in the third quarter. We did see an expected drop in paying users from our Teams plans in the wake of the pricing and packaging changes that we've been talking about. We also did see some softness around some of our Plus users, particularly on mobile due to the challenging macro environment. As far as breaking that out, I would say that the larger portion of the drop does stem from the pricing change. As far as looking forward, we don't formally guide to paying users. We do expect our Teams pricing and packaging change to have an impact on net new paying users. However, we're encouraged by the early signals we're seeing and are confident that this pricing change is a net positive to ARR in the long run.

Our next question comes from Jacob Staffel with Goldman Sachs. You may proceed.

It's Jacob here. I to ask around ARPU real quick. It seems like the last, we'll call it, five or six quarters, ARPU has kind of been floating around in that like $133, $134 range. And obviously, a portion of that is due to the Family plan and the six seats that are included in that. But given all the product innovations that have been recently released, how are you thinking about future acceleration of ARPU?

This is Tim. So we did end the third quarter with ARPU at about $134, which was up about $0.52 year-over-year. And this was driven by benefits from our pricing initiative and a continued mix shift to our premium SKUs. Now offsetting that, there was nearly a $3 headwind from FX. So FX plays apart from a headwind perspective, as does, as you mentioned, the Family plan. And looking forward, we don't formally guide to ARPU. There continue to be some factors that may impact our trends -- pricing that will continue to be a tailwind to ARPU FX. Again, we expect FX headwinds to intensify, exiting the year and into 2023, assuming current rates hold. And then, of course, the Family plan, as you mentioned. And so there are puts and takes here, which is why profitably growing our total ARR base versus optimizing for a specific ARPU is our priority.

Thank you. That concludes our Q&A session. That concludes the conference. Thank you for participating. You may now disconnect.